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Financial Planning: Backdoor Roth IRAs and Home Affordability

By Matthew Frankel, CFP® – Nov 20, 2021 at 7:17AM

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Here's what our experts have to say about these two timely topics in the world of personal finance.

There has been talk in Washington lately about the possibility that Congress might get rid of the so-called "backdoor" Roth IRA in the not-too-distant future. And soaring home prices in the United States have made it more expensive to become a homeowner. In this Fool Live video clip, recorded on Nov. 3, Certified Financial Planners® Matt Frankel and Robert Brokamp give their takes on these two topics. 

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Robert Brokamp: I'm going to talk a little bit about the backdoor Roth, something we've talked about pretty regularly here on the show. First of all, the Roth is particularly appealing these days because we are at tax rates that are at the lowest levels we've seen in decades, and tax rates are likely to go up in the future. In fact, they definitely will go up at the end of 2025 because that's when the 2017 tax cuts expire. 

Plus, with burgeoning federal budgets, underfunded Social Security, underfunded Medicare, most people expect that tax rates have to go up. One way to protect your retirement from higher tax rates is a Roth. You can contribute to a Roth in a couple of ways. First of all, if you have a Roth 401(k) at work -- or a Roth 403(b), Roth TSP, if you're a federal employee -- you can always contribute to the Roth. There are no income limits on the Roth 401(k), 403(b), TSP. There are income limits on the Roth IRA. If you make a certain amount, you can't contribute to the Roth IRA.

So there's this trick called the backdoor Roth IRA. You contribute to a nondeductible Traditional IRA, and then you convert to a Roth. Now, there was discussion maybe a month or two ago about Congress eliminating the backdoor Roth. So there was a lot of talk about doing your backdoor Roth now while you can. Well, the latest version of the Build Back Better, Bill or Plan, whatever they're calling it, has stripped that out. So it looks like the backdoor Roth is safe for now.

If you're not sure about the income limits for the Roth IRA, not sure what the backdoor Roth is, I'm going to put an article in Slido from my colleague here, Matt Frankel, that he wrote recently that will explain the backdoor Roth for you. In the meantime, while I'm doing that, Matt, what do you have to tell the crowd?

Matt Frankel: I wanted to talk a little bit about homeownership. I recently saw an article that said homeownership is at its lowest level of affordability since the financial crisis. That's pretty bad. And it's easy to see why they would say that. The average home price in the U.S. is up by about 20% since the start of 2019. But there's also the other side of it -- that mortgage rates are a lot lower than they were then.

So I want to put in perspective how much more expensive homeownership has gotten, and how much more it hasn't gotten that expensive, things like that. Just the headline numbers I saw today, because we just got a glimpse at average mortgage rates. The average mortgage rate today is about 3.24% on a 30-year fixed-rate mortgage. That's down from 3.3% last week, it's coming back a little bit. A lot of that has to do with demand fading from the busy and crazy summer housing market that we saw. But this is down sharply from before the COVID pandemic. At the start of 2019, the 30-year mortgage rate was about 4.4%. In mid-2019, it was still hovering a little bit above the 4% level.

So what does that mean for homeownership? On a $300,000 mortgage, a 4.4% interest rate like we saw at the start of 2019 and the 3.24% average interest rate we're seeing today is a difference of about $200 on your monthly payment -- on the same amount of money. That's a 15.2% discount from what the same amount of money would've cost you to borrow at the beginning of 2019 versus right now. Now, as I mentioned, home prices are up by about 20% since then. But when you take the difference between the two, the average mortgage payment is only about 4% higher on a new existing home purchase.

Now, having said that, there are parts of homeownership that have gotten more expensive. That's just talking about the principal-and-interest portion of your payment. Keep in mind that property taxes are based on your home's value, for the most part. Same with homeowners insurance -- [the premiums] are based on replacement costs. Not only that, but your down payment would be 20% more than it would be for the same exact house and the same percentage down. So homeownership has gotten expensive, yes. But the lower mortgage rates have helped to offset that. The whole point of this -- if you want to be a homeowner and you're a renter, don't necessarily give up the dream. Talk to a lender and see what's out there, see what you can afford, and then go from there.

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